Yesterday on the way in to work I passed a guy in traffic that was heading out of town in the opposite lane. It was 65 degrees that morning, the air was crisp, the skies were bright blue, it was the type of weather that could even make a swine-flu victim feel great about being alive. Attached to the top of his vehicle he had two kayaks and a mountain bike…and he wore a big smile. The first thought through my head was “there’s a guy that’s not shorting the 20 year Treasury”. At that point I started thinking that maybe I need to cover my short position and take some time off. You can see that I didn’t though because I’m here writing this….and I’m still short the 20 year Treasury.
This morning we have yet another big rally in the Treasury market. This time we’ve pushed the 10-year Treasury down to levels it hasn’t seen since May. The 10 year is trading at a 3.21% right now and the 30-year yield is under 4.00% again. There was a lot of economic data released this morning and it was a mixed bag. Market sentiment has taken another seismic shift over the last month or so.
Back in the spring-time hope was welling up everywhere as many people placed bets that this economy was staging a comeback. In early 2009 the markets began to shake loose from the vice-like grip of fear that had haunted them for so many months. Buyers returned and spreads narrowed in as it became apparent that the financial system would not experience a catastrophic melt down. As we stabilized in early spring there were largely two views on the future. One was the optimistic view that we’d see a “V” shaped recovery and quickly return to normal economic growth. The other was in my view more realistic that this economy would limp along sideways for some time. By the time May rolled around it looked like the optimists had the ball and were moving it down the field. Talk of deflation and economic disaster gave way to talk of “green shoots” and perhaps some inflation.
The optimism that took root over the spring and summer is under some pressure as we move into the 4th quarter. If you looked at a chart of the markets movement this year and you weren’t told what you were looking at, you might think you were observing the activity of a bipolar gambler. The trend has been way up one minute, way down the next, and wildly unpredictable the whole while. Below is a screenshot of this morning’s activity showing Treasury prices moving up sharply. The major domestic equity indices are all off, the 10-year Treasury is up over ¾’s of a point and the long bond is up almost a point and a half.
Below is a chart of the 10-year Treasury yield. I marked this morning’s level in the cross hairs. The graph points out that the last print we had at a 3.21% level was way back in May when the short-lived optimism phase was just kicking in. We’re now approaching that level again from the opposite direction as Mr. Optimism gets introduced to Mr. Reality. The economy is not heating up, initial jobless claims are still running well above 500k a month, despite massive government stimulus GDP is still negative, auto sales have dropped now that the government isn’t funding them anymore, the housing market is still a mess, and (drum roll please) deflation concerns are back in the news. What “positive” news there is comes to us in the form of numbers that are LESS NEGATIVE than expected. While that is a necessary pre-condition to get things turned around it doesn’t mean that things will go positive any time soon. That is what has this market spooked…there is little faith that robust economic growth will return any time soon.
Today’s data
Below is the list of economic data that we got this morning. Numbers going the wrong direction are highlighted in red, those going the right direction are in green, and those that are unchanged or didn’t have a survey estimate are in white.
You can see that it’s a mixed bag this morning. Personal income and spending were both up a bit, as was construction spending, but the job losses just keep piling up. If you monitor the headlines you’ve likely seen an increase in the references to the unemployment rate staying elevated for quite some time...perhaps years at the current levels. If the prognosticators calling for high unemployment for years are correct then it would seem even more likely that the Fed is also correct in saying that rates will remain low for an “extended period”.
When will rates rise?
2010 is only 3 months away. The forecasts for rising rates in 2010 look like more of a long-shot every week. The economy is still in the ditch and the Fed missed its first deadline to exit its role as the largest buyer in the MBS market. The whole idea of the Fed cutting rates and buying bonds was to keep rates low so that consumers and small businesses could have adequate access to credit. They cut the overnight rate to zero which anchors the short end of the curve, then they bought Treasury bonds on the open market to push yields lower still, then they bought 34% of the mortgage market to absolutely crush the spread that existed between MBS and Treasuries. Mission accomplished. They got rates really low and spreads really tight. Now however they own a lot of MBS product that nobody else wants at current levels and they can’t exit this role without causing spreads to widen again. The original deadline to cease MBS purchases was October…this got extended to the first quarter of 2010. The Fed understands that if they quit buying then spreads will blow back out quickly by some degree. With the economy in its current condition they really aren’t excited about seeing borrowing costs skyrocket so they continue the program…they will keep rates artificially low through the magic of the Feds Balance Sheet. I’ve attached a graph of the Feds balance sheet for reference; it’s an interesting sight.
In addition to the weekly economic data, prepare yourselves to start hearing about retail sales heading into the holiday season. High unemployment and limited access to credit cards paint a sad picture of a 4th quarter consumer. I hope I’m wrong but it’s difficult to see a strong bout of sales to help the retailers finish off 2009. This is the type of thing that could cause the mood of the market to stay depressed through year end.
I realized while proof reading this update that there isn’t a lot of good news to report. I too need a break from it all so I think I’ll put in a full day tomorrow then take the next two days off.
If you have any questions on this material just let me know.
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